Fund view 2011 - Permal backs long-short and M&A hedge funds

LONDON (Reuters) - Fund firm Permal is backing hedge funds betting on U.S. large cap stocks, mergers and acquisitions and natural resources, believing a benign 2011 will provide the right conditions for them to prosper.

Greater stock selectiveness by investors and low valuations should help long-short funds, which bet on rising and falling prices, while quantitative easing (QE) should boost commodity prices, said Omar Kodmani, senior executive officer at Permal Investment Management Services.

"Our view is that 2011 could be a benign scenario, with the U.S. economy not having a double-dip, quantitative easing providing a floor for risk assets, Europe avoiding a sovereign crisis and emerging markets and commodities doing well," he said in an interview at Permal's offices in upmarket St James's.

Kodmani has increased exposure to long-short equity funds in the firm's global portfolio to 24 percent from 19 percent.

"We like developed markets large-cap -- we like U.S. valuations from an equity standpoint and we like the opportunities for stockpicking," he said.

"In the second half of 2010 we've seen a lot more dispersion in equity performance which makes for a more favourable backdrop."

Hedge funds can suffer during periods of high market volatility, for instance if investors sell stocks indiscriminately rather than focusing on their fundamentals.

Kodmani has also increased exposure to natural resources and commodity funds to 10 percent from 4 percent.

"In a benign scenario with reasonable global growth, QE will push up risk assets and this will lead to elevated commodity prices," he said.

"We seek enhanced returns through specialist managers such as grains traders who can profit from short-term supply/demand imbalances as well as the longer term secular outlook for agricultural commodities."

Permal's funds of hedge funds are up between 5.5 percent and 9 percent year-to-date, according to a source close to the company, while the average portfolio is up 3.4 percent in the first 11 months of the year, according to Hedge Fund Research.

M&A

Kodmani is also backing merger arbitrage funds, which tend to profit when markets are buoyant and companies feel more confident about buying their rivals.

"Spreads for merger arb are higher than usual because (bank) prop desks are less active. There's a large amount of cash on corporate balance sheets -- and the way for corporates to grow market share in a slow growing economy is through M&A," he said.

Event-driven funds have attracted $11.6 billion (7.45 billion pounds) of the $42.3 billion allocated net to hedge funds in the first nine months of this year, according to HFR, helped by a surge in interest in M&A funds earlier this year.

However, Kodmani said he had cut exposure to long-biased hedge funds and taken profits in some event-driven funds such as restructuring and special situations, although not merger arb.

Meanwhile, he said macro funds, which bet on moves in bonds, currencies and commodities, could also prosper as Europe's sovereign debt crisis rolls on.

"They're likely to see lots of trading opportunities. The (sovereign debt) issues won't appear again until the end of 2011 or early 2012, but markets tend to bring these forward so 2011 could be a year for event risk."

(Editing by David Cowell)